More disciplined M&A on tap for gold miners in 2014

When the market was hot from 2010 through 2012, mid-tier Alamos Gold (TSX: AGI; NYSE: AGI) stayed on the sidelines of an otherwise active M&A scene because valuations for companies were “through the roof,” says the company’s president and CEO, John McCluskey.

“The only way you could step into that market and feel at all comfortable is if you felt gold was going to US$3,000 per oz., or something — which we did not.”

More recently, as the gold price cooled, Alamos found valuations were at last coming down to more reasonable levels. Last year, the debt-free company, which produced 190,000 oz. gold at its Mulatos gold mine in Mexico in 2013, was involved in three takeover bids.

However, despite the decline in valuations since 2012, McCluskey says it’s still difficult to find compelling transactions.

“Generally we’re trying to acquire public companies and there’s a sufficient amount of information in the public realm for us to do a desktop analysis,” he says. “After we finish that analysis, very few companies actually prove to be worth approaching. So the list of potential targets is remarkably short.”

Even when Alamos has found worthy targets, it has been disciplined about the price it’s willing to pay for them.

Last year it bought Esperanza Resources for its advanced-stage Esperanza gold project in Mexico for net cash of $45 million, and paid only $3.5 million for Orsa Ventures, a junior with an early stage project in Oregon.

And it declined to get into a bidding war when its biggest offer of the year, a $780-million hostile bid for producer Aurizon Mines, was bested by a friendly $796-million offer by Hecla Mining (NYSE: HL).

Instead, Alamos abandoned the bid, in part, because of a $27.2-million break fee Aurizon had agreed to pay Hecla.

 “In pursuing our growth objectives, we will not deviate from the fiscal discipline that has made us one of the world’s most successful gold companies,” McCluskey said in a March press release.

Another year of disciplined M&A

The discipline that Alamos has displayed through both rising and cooling markets has spread to the entire gold sector.

A report released in late February by PwC confirms that discipline returned to the market in 2013, a year that saw the gold price tumble by nearly 30%.

The report, which focused on global mining M&A, reveals that deal volume fell 20% last year (to 1,437 deals) compared with 2012 — which was already the worst year for deal volume since 2005.

Deal value dropped even more by 35% to US$36 billion — or if the huge Glencore Xstrata (LSE: GLEN) merger of 2012 is included, by 67%.

And while PwC predicts an increase in M&A this year, there won’t be big-ticket acquisitions.

“I think people are excited because gold prices have returned a little bit, and there’s one big sort of blockbuster deal that’s been announced, which is Goldcorp-Osisko,” says John Gravelle, PwC’s global mining leader.

However, Gravelle isn’t expecting many other large $2-billion-plus deals, especially when it comes to public company takeovers. “It’s going to pick up a little bit, but it’s not going to be a blockbuster year.”

In the gold space last year, majors sold non-core assets and focused on cost-cutting — a trend Gravelle expects to continue this year. He also sees a trend toward joint ventures rather than outright acquisitions, again with the aim of reducing risk.

Companies that have recorded big writedowns in the recent past will need to show they can cut costs and deliver profitability on a sustainable basis, and probably won’t be ready for larger M&A deals until 2015.

Geordie Mark, senior gold mining analyst at Haywood Securities, agrees companies will be cautious in any further acquisitions until they can prove they can deliver with their current assets.

“That may take a bit of time, several quarters or more, but ultimately, those who do make acquisitions would probably be more likely do accretive acquisitions — pick up another producer or the like — that somehow adds synergy to their operations, or will lower their cost base,” he says. “So more conservative, less aggressive acquisitions and mergers I would say from the larger producers.”

Mark expects to see more consolidation within the gold-mining space, with the result being “fewer companies and a greater collation of assets within fewer companies, both at the development level and the producer level.”

Recent examples of such deals include: last year’s $183-million merger of equals between Asanko Gold (TSX: AKG; NYSE-MKT: AKG) and PMI Gold, which created a company with a larger collective cash position and asset base, and development synergies between its assets in Ghana; and Primero Mining’s (TSX: P; NYSE: PPP) $220-million takeover of Brigus Gold, which will see Primero augment its production in North America.

Mid-tier companies, which are expected to be aggressive acquirers this year, will also be looking for smaller deals that can be easily funded, create obvious synergies and won’t break the bank — or prove crippling if things don’t work out down the line, Gravelle says.

While mid-tiers will remain cautious, they can’t ignore the opportunities wrought by the plunge in the gold price and valuations.

Like Alamos’s McCluskey, Joseph Conway, president and CEO of mid-tier Primero Mining, says that the drop in the gold price opened up M&A opportunities for the company in 2012 and 2013. Owner of the San Dimas gold–silver mine in Mexico, the company had been looking to diversify production though an acquisition since 2010.

The gold price “forced people to look and see if there are other alternatives to how they’re going to fund their development and the growth of their own assets,” Conway says. “I think that’s largely what happened with the case of [Cerro Resources and Brigus Gold], in some respects.”

In December 2012, Primero struck a $120-million, all-share deal to buy ASX-listed Cerro Resources (which held 69% of the Cerro del Gallo development project in Mexico), and a year later, it announced a friendly transaction to buy Brigus Gold and its Black Fox gold mine in Ontario.

While Brigus wasn’t particularly distressed, it had a significant amount of debt relative to the cash it was generating, Conway says, especially relative to its development plans.

“We have the financial resources to develop the mine at an efficient pace,” Conway says. “Our budget for this year is probably in the order of $35 million to $40 million. For Brigus, with its existing capital structure, that would be a challenge for them to invest that kind of money into the mine.”

With the investment, Conway says, Primero could accelerate the development, spend more money on exploration and look at the opportunity with depth potential.

Conway expects more M&A this year, as more companies find themselves in trouble.

 “I think it really comes down to companies getting themselves to a point where they have a critical level of cash,” he says.

“Let’s say a junior development company or a company that’s got a single asset, if they get down to $15 million or
$20 million in cash, then they realize they really have to do something. And . . . lots of companies — on the producing level, let’s say — are still OK. How they’ll be in 12 months from now is a different issue.”

A realignment of expectations

In a sign that development-stage companies are adjusting to the new paradigm of lower commodity prices and tighter equity markets that are less willing to fund development projects, Geordie Mark of Haywood says that juniors are adjusting their expectations downward.

Mark says companies such as B2Gold (TSX: BTO; NYSE-MKT: BTG) have reported that target companies with development projects have become more willing to engage in M&A discussions, which start with the signing of confidentiality agreements.

“I think boards have become more aware of how difficult it is for them to go forward by themselves and can see greater value in becoming integrated into an existing producer, or a merged entity of equals,” he says. “They’re getting realigned with where the market is ultimately and that can take some time with what the original expectations were in 2011, or earlier.”

Alamos’ McCluskey notes that investors, who really set the price of a company, also need to take a more realistic view of what development projects are worth.

McCluskey says there won’t be much M&A activity this year if the market expects buyers to pay based on the spot price for gold, and that development risk, time to production, execution and permitting risk all have to be factored in.

“There are very few CEOs in my position right now that are willing to step in and pay spot,” McCluskey says. “There’s just too much volatility in the market. We’ve seen gold go up and down US$50 per oz. or more on any given day.”

Alamos is looking for acquisitions with an all-in cost of less than US$1,000 per oz., McCluskey said in a February interview. That includes the acquisition cost and all-in sustaining costs, plus the capex to build out production. 

Even at that level, there isn’t much margin when you consider gold price volatility and risk, McCluskey says. “So even at US$1,000 per oz., you have to have a fairly optimistic view on where gold is going to go long-term.”

— This story originally appeared on www.miningmarkets.ca, a sister publication of The Northern Miner.